Tag Archives: corporation tax

Reform of Corporation Tax Losses and Corporate Interest Restriction Regulations

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The Corporate Interest Restriction is one of two strands of the Governments modernisation of the UK tax system; with the other strand being the reform of corporation tax losses. My blog of 25 June made reference to the impact of the Corporate Interest Restriction (CIR) Regulations. Although it was mentioned in the context of both inward investment and property investment it is not restricted to those two arenas.

For many years the UK has been at the forefront of the Organisation for Economic Corporation and Development’s best practice, including measures against Base Erosion and Profit Shifting (BEPS). One of the strands of BEPS is prevention of excessive tax deductions for financing costs. Typically the financing would be intra-group with the lender being in a tax advantaged jurisdiction and therefore high levels of intra-group debt or higher interest rates would save the group tax.

CIR for groups with UK interest deduction over £2m

CIR came into force on 1 April 2017 and only has a fiscal consequence for groups whose UK interest deduction is more than £2m. £2m was taken by the UK Government as being a sum which excluded the vast majority of organisations from the legislation. If UK interest is more than £2m then there are formulaic calculations to determine the tax relief which can be claimed. Tax relief can be claimed on sums as great as 30% of EBITDA (as adjusted for tax). The Government acknowledges that this ceiling can be particularly restrictive for certain groups and therefore it is possible to apply a different ratio; one which is more dependent on external financing and UK profitability. However, this alternative strategy needs management and therefore the relevant election should not be made before medium term profit forecasts are developed.

When the interest restriction applies a group company should be appointed to notify HMRC of the group’s interest restriction and how the group wishes for that restriction to be allocated amongst the group companies. In the absence of the election HMRC can allocate the restriction pro-rata between the companies and HMRC’s allocation may not be appropriate for the group’s tax profile.

Corporation Tax Loss Relief

CIR was not the only new matter introduced on 1 April 2017. There was a revision to the fundamentals of corporation tax loss relief which became effective from the same date. Prior to 1 April 2017 unrelieved trading losses could only be carried forward and offset against future profits of the same trade. Other types of losses had their own specific restrictions.

From Spring 2017 there was a relaxation of the use of carried forward losses in a way to generate greater flexibility. However, conversely there was a restriction on the amount of the brought forward loss which could be offset in any one year. The relaxation applies to all corporates with the restriction only applying to larger, more profitable, companies. This mismatch is designed to assist the SME sector.

The relaxation allows losses to be carried forward against total profits of the same company and therefore makes them more flexible. Additionally losses can now be carried forward against subsequent profits of certain group companies, and not just the future profits of the loss making company. Before accessing this flexibility there are certain conditions to be met and those conditions cannot be assumed to be satisfied. They need to be checked.

The restriction occurs if losses exceed £5m. Prior to April 2017 brought forward losses could be offset against subsequent income without a ceiling. From 1 April 2017 the first £5m of brought forward losses can be used without restriction. However if profits of the later period are greater than £5m then only 50% of the profit above £5m can be offset by losses brought forward.

Although the Government feel that setting a restriction above £5m will remove all SMEs from the legislation I do not believe this is the case. It is common for our property development clients to have phenomenal years as sites come up for sale. If there are brought forward losses (e.g. due to the cost of financing in the period of building) then our clients cannot guarantee that all the losses are available for offset against subsequent profits. We are having regular discussions with property clients about sales forecasts and the extent that sales may occur over a number of years. Although a spread of sales is more common for residential development it may also apply to commercial sites.

1 April 2017 was a watershed for corporation tax in the UK with the introduction of both CIR and the group loss relief rules. Undoubtedly there are groups who will benefit greatly from the new rules and also groups which will experience restrictions.

Overseas businesses setting up UK subsidiaries

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With the Brexit deadline looming we are finding greater amounts of interest from overseas businesses wishing to set up in the UK. For some of these businesses (e.g. those based in the Republic of Ireland) the reasons for expanding into the UK are self-evident. Others come to the UK for more subtle reasons, such as benefiting from the relative weakness of Sterling.

Ease of company incorporation in the UK

Features of the UK landscape are the ease of company incorporation and the ability to have company directors who are all non-UK residents. When compared to the Republic of Ireland our 17% corporation tax rate is unattractive. However this does not appear to dampen the appetite for Irish businesses setting up subsidiaries in the UK.

Structuring for expansion into the UK

When considering expansion into the UK there are a number of decisions which have to be taken about structure. As identified in my blog on the development of the UK corporate tax landscape it is important to model the impact of financing on the UK results as well as modelling the quantum of any opening year losses.

Withholding taxes after Brexit

Typically Irish ownership would access the benefits of the EU Interest and Royalties Directive in order to avoid withholding taxes on intra-group interest payments. In advance of the UK withdrawal from the EU in 2019 the terms of the UK tax treaty may be more relevant and making it more important to register as a borrower under the treaty passport scheme.

As the UK does not have an outbound dividend withholding tax, our departure from the EU does not make dividend withholding taxes a concern. Although this may be efficient as a mechanism for the repatriation of profits out of the UK the impact of dividend income receipts in the home state would still need to be understood.

UK Boards and non-UK Directors

Many inward investment groups have non-UK directors on their UK Boards and this is a common mechanism to enable commercial control of the UK subsidiary by home state persons. Like many countries the UK has a concept of management of control for company tax residency and the impact of our domestic rules should be considered when determining directors numbers, residence and their powers.

Audit requirements

Even if the UK company may not be expected to be particularly large, one still has to consider consolidated accounts and their audit requirements in the home state. This may lead to obligations to audit the UK subsidiary and for the UK auditors to have tight reporting deadlines in order to fit in with group timetables. Typically our audit teams are required to audit the financial statements of the UK subsidiary which have been prepared under UK GAAP and provide GAAP adjustments for overseas parent consolidation. Although this is not necessarily relevant for investment from the Republic of Ireland it can be an important factor to timetable into UK work when reporting to other countries, such as the US.

Future visa requirements

No business is a success without the right people. Expansion into the UK regularly results in staff coming to the UK to manage the early development of the UK subsidiary. Nationals from EU countries have not had to consider visa issues. This may change in the future. The group parent should not assume that its employees can come to the UK without visas. For example an Irish parent company may second staff to the UK to manage the early stage of the UK subsidiary without considering that the staff are, say, Australians working in Dublin. Visa requirements for any secondments need to be explored.

Sending staff to the UK

The UK has tax breaks for movements of staff which may be of benefit. The extent to which the transfer is a temporary matter of a few months or a long term matter should be identified at the outset. This is to ensure that social security is paid to the right country and any relevant terms of bi-lateral social security agreements are applied. Even a short term transfer may result in PAYE obligations or reporting requirements which need to be managed.

Longer term staff transfers inevitably result in the individuals falling into the UK income tax net. Planning for salary equalisation is important when offering the individual a long term transfer. Also whilst developing their total remuneration package it is important that the impact of share options granted to secondees is understood in the UK and home state.

For both secondees and UK employees the HR policies associated with UK employment need to be identified and where appropriate, group policies flexed to meet UK employment laws.

Plan for setting up in the UK

The decision to come to the UK is a relatively easy one for many overseas businesses faced with the uncertainty of Brexit. For our friends in the Republic of Ireland it is possibly an easier decision to make, especially given our close histories, legislative approach and common language. However that does not prevent the need for planning by any group considering coming to the UK at both the tax level and the employee level. We are finding that the most successful businesses are those which engage with us on these matters at an early stage.

Non-resident corporate landlords: New Consultation in 2017

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There will be a consultation on bringing non-resident companies receiving taxable income from the UK into the corporate tax regime.  It was announced by Philip Hammond, the Chancellor of the Exchequer in his Autumn Statement and is due to open in Spring 2017.

Who is affected?

This would affect;

  • non-resident  companies receiving UK taxable income not through a permanent establishment in the UK or
  • non-resident companies receiving rental income from investment property in the UK.

The stated purpose is to deliver equal treatment for all companies.

Clearly we will need to await further details to understand what is being proposed.

Pros and Cons

On the one hand, bringing non-resident companies into the corporate tax regime will reduce their tax rate from 20% to 17% in the medium term.  There may also be increased scope to claim certain expenses of running the company rather than limiting expenses to those related to the property rental activity.

However, on the negative side, two new rules are being introduced for corporation tax in April next year which could adversely affect the tax position of non-resident corporate landlords.

  • Firstly, a cap will be imposed on loan interest deductions where the group-wide net interest costs exceed £2 million.
  • Secondly, in some circumstances there will be restrictions on the ability to use brought forward losses.
  • In addition whilst the Autumn Statement referred to taxable income, one cannot exclude the possibility that capital gains will also be brought into the net and be taxed.

Non resident landlord scheme

In relation to the loan interest cap, the original consultation on this matter had focused on  corporation tax although it was recognised that there was an issue relating to corporate landlords who were paying income tax on rental income under the Non-resident landlord scheme.  The treatment of non-resident corporate landlords in respect of the interest relief cap had not been settled.

In conclusion

It may be that subjecting non-resident corporate landlords to corporation tax is a neat solution to extending the interest cap to these companies.  However, whilst the interest cap will take effect in April 2017, it  seems likely that the application of these rules to non-resident corporate landlords would take effect in April 2018.

Watch this space.

 

And now – the case for the Prosecution

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Many UK-based businesses, particularly at the smaller end of the SME market, support the aims if not the conduct of UK Uncut and applaud the politicians playing a form of class warfare against multinationals over their failure to contribute “fair” levels of Corporation Tax. Are they wrong?

They are. What they’re missing are two fundamental ingredients to the argument – they pay more Corporation Tax than they need because they don’t make full use of the panoply of allowances and structures larger corporates use, and when it comes to the smallest businesses, what they pay in Corporation Tax is merely a replacement – usually discounted – of the Income Tax they would suffer were the company profits taken as personal income.

Why not use the allowances? Fundamentally, most tax breaks are against costs incurred. If the tax break is only worth 24-odd % of the cost incurred to obtain it, only a fool would incur that cost unless there was a sound business reason for doing so. And smaller companies, particularly owner-managed ones, are either reluctant or unable to incur significant extraneous cost – so they don’t get the associated tax breaks.

If, like Starbucks, you give away equity in your own business to your employees, you’ll get a tax break. How many SME’s would contemplate doing that? If, like the same company, you’re prepared to fund an office infrastructure in Switzerland to handle all your purchasing requirements, then some part of your overall profits will be attributable to your Swiss location – hardly realistic for most SME’s.

If you’re prepared to move your corporate headquarters to Eire, incur the establishment costs over there, pay the exit charge on leaving the UK, then yes, you can benefit from the lowest Corporate Tax charge in the EU. But it is hugely complex and comes with an enormous price tag, both in terms of cash and time.

Better still, move to Mauritius. Get a really, really low corporate tax rate. More complex still.

If you think you’re going to be making Capital Gains, emigrate to Belgium – no CGT!

If you’re looking at VAT on distance-selling, try Luxembourg.

Work all over the place, but not in Hong Kong? Get yourself employed by a Hong Kong company, make sure you become resident there, you’re home free! No tax!!

And if you’re French resident, own your own company generating income from Intellectual Property and taking remuneration and dividends in excess of £800K pa – quick! – get out!! – cross the Channel and save yourself, and your company, a fortune!!!

And that’s the case for the Prosecution. It’s nothing to do with the taxpayer, it’s everything to do with the competition between countries to entice business into their territory. Why do they do it? Because business creates employment, and the vast bulk of government revenues are extracted by taxes on income and taxes on expenditure. Better by far to have more than 700 Starbucks here employing 9,000 people than have another 700 empty stores and 9,000 more on the dole. It pays no corporation tax? Legitimately? Not an issue.

There’s nothing “fair” about tax. It’s whatever each government wants it to be. A revenue-collecting device. An enticement. A discouragement. You don’t get foreign companies setting up in your jurisdiction by discouraging them from doing so. One can hear voices off-stage shouting “hurrah! Let them go!! We don’t want those nasty multinationals here!” – they’re plain wrong. We want the employment prospects, and as consumers, it seems we want what they offer.

Where the UK gets its taxes:

Income
tax		 £155 Billion 26% of tax revenues
National Insurance £106 Billion 18% of tax revenues
VAT £102 Billion 17% of tax revenues
Corporation Tax £44 Billion 7% of tax revenues

The Case for the Defence

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Some years back one of my clients established an Indian subsidiary to undertake ongoing programming work that had been undertaken in the UK. My client was a loss-making business, VC backed, in a technology sector, and it decided to outsource these functions to India to reduce its cash burn rate.

We were staggered to receive a report from the Indian division of a Big 4 firm advising that the profits the Indian authorities would expect the Indian subsidiary to declare were the profits that would be made by a US firm providing the same service. That sounded to me like nonsense – if the notional US firm made a 10% uplift on a $2m cost base comprising staff cost and little else, the Indian authorities, on a cost base equivalent to no more than $400K, would be required to make a 50% uplift. I couldn’t believe that independent software companies in India were winning overseas business that would generate anything like that kind of number.

And so it transpired. Working with another Indian accountant, we identified a collective of local independent software businesses offering the same type of service. We analysed their results, we adjusted them to reflect the fact that our Indian company was fully protected by its parent against almost all business risks to which they were exposed, and we concluded the profits the Indian company should declare were equivalent to a 10% mark-up on cost.

Strictly in accordance with OECD guidelines. Obviously we’d have been on stronger grounds were India a member of the OECD, but at least we had a result based on an analysis justifiable by internationally recognised standards. Importantly, we had a result that would be acceptable in the UK as well as being defensible in India.

Roll the clock forward a few years, and what do we find? Here, in the UK, a founder member of the OECD, we have politicians grandstanding about global companies not paying their fair share of tax, we have protest movements invading multinationals’ retail outlets and cajoling consumers to purchase elsewhere. Why? Because the global companies concerned, operating strictly in accordance with OECD guidelines on Transfer Pricing, appear to suffer a lower rate of Corporation Tax on UK-generated business than that suffered by indigenous businesses operating only in the UK.

Take Amazon as an example. It has significant UK turnover – £7.6Bn in the past 3 years – on which it’s paid next to no Corporation Tax. It achieves that turnover because large numbers of UK citizens rate its service as excellent – it’s simply that much better than its competitors. But does it earn its profits here? Its business is predicated on its technology platform, which wasn’t developed here, isn’t owned here, and isn’t maintained here. Without that platform it has no business. It works on tight margins only improved through global purchasing procedures, again not based here. So why should profits attributable to facilities operating outside the UK be taxed here? The simple answer is they shouldn’t. If the UK seeks to tax those profits here, then what about the territories where those profits are being earned? Should they just accept a UK unilateral declaration that it is taking over taxing powers on profits attributable to them, or should they turn round to Amazon and continue levying tax as they do currently? Should Amazon be required to pay tax twice on the same profits?

Exactly the same scenario applies to Google. It’s the world’s favourite search engine, but it isn’t here and an insignificant proportion of its profits are attributable to UK activity. So why should it be subject to anything other than an insignificant amount of UK Corporation Tax?

But the grandstanding doesn’t stop at multinationals. The latest in the firing line is The Ritz Hotel. Mentioned in a BBC article. Why? Because its shareholders aren’t resident here, and the company, whilst profitable, pays no Corporation Tax.

But the UK business tax regime has never taxed profits as they appear in a company’s accounts. It taxes adjusted profits figures, and once those adjusted profits are determined, it allows tax losses in one group company to be offset against tax profits of another. Has that suddenly become a sin?

It’s time the media and the politicians found some other outlet for their spleen. Seeking to tarnish the names of legitimate commercial enterprise because the result of their obeying the rules doesn’t satisfy some ill-thought-through sense of what’s right simply establishes in the observers’ mind the sheer stupidity, even cupidity, of the protagonists.

Could the tide be turning against the tax benefits of incorporation?

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The Telegraph reported this weekend that Moira Stuart, the current face of HMRC’s Self-Assessment campaign, is charging for her services via her own service company, allegedly to pay tax at the lower 21% corporation tax rate rather than the 50% top income tax rate. Coming hot on the heels of the Ed Lester and the Student Loan Company scandal, where a similar company was used apparently used to avoid top rate tax and national insurance, it is clear the media spotlight is now focused on the potential tax advantages of running a business through a company.

Whilst anti-avoidance measures are in place to counter the most blatant use of personal service companies, the fact is that with reducing corporation tax rates and increasing national insurance it has become ever more tax efficient to incorporate a small business over recent years.
Tax saved by operating a business through a company compared with a sole trader:

Profit  2008/09  2009/10 & 2010/11 2011/12
£10,000 £324 £274 £299
£15,000 £674 £624 £749
£20,000 £1,024 £974 £1,199
£30,000 £1,724 £1,674 £2,099
£40,000 £2,424 £2,374 £2,999
£50,000 £3,423 £3,710 £4,257
£75,000 £3,485 £3,772 £4,757

We will have to wait to see whether George Osborne will respond to the current media attention to this matter, but I think it likely we will see some measures taken in the near future to level the playing field between the incorporated and the unincorporated small business.

One route would be to increase corporation tax for small businesses, perhaps by scraping the small companies’ rate, although this would be politically difficult for a pro-business conservative Government. Alternatively, HMRC may revisit the possibility of applying national insurance to dividends for small companies.

The difficultly that all governments face in dealing with this matter is not some much to do with levelling the playing field between the incorporated and unincorporated small business, but it is how to do this without encouraging many employed individuals to try to reclassify themselves as self-employed. At the moment however, it remains a legitimate and potentially tax efficient option to incorporate a small business.

Graeme explains the associated companies rules

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The number of associated companies determines effective rates of corporation tax and the extent to which tax is paid by quarterly instalment.
If you want to find out more then you can read Graeme’s TAXline Graeme Blair

This pdf version of the article is reproduced with the kind permission of TaxLine who hold the copyright.